The headline reading for U.K. inflation is expected to increase an annualized 2.4% in October and the rebound in consumer price growth should heighten the appeal of the British Pound as it dampens the Bank of England’s (BoE) scope to expand its balance sheet further. As the U.K. emerges from the double-dip recession, with the Funding for Lending scheme already under way, an increased number of central bank officials may drop their dovish tone for monetary policy, and the quarterly inflation report may no longer highlight the risk for undershooting the 2% price growth target as the economic recovery slowly gathers pace.

Recent Economic Developments

The Upside

Release

Expected

Actual

Gross Domestic Product (YoY) (3Q A)

0.6%

1.0%

Retail Sales ex Auto Fuel (MoM) (SEP)

0.3%

0.6%

Average Weekly Earnings inc Bonus (3MoY) (AUG)

1.6%

1.7%

The Downside

Release

Expected

Actual

Industrial Production (MoM) (SEP)

-0.6%

-1.7%

Purchasing Manager Index (OCT)

0.4%

0.1%

GfK Consumer Confidence Survey (OCT)

-28

-30

Faster wage growth paired with the resilience in private sector consumption may encourage businesses to raise consumer prices, and we may see the BoE start to discuss a tentative exit strategy in the following year as the headline reading holds above the 2% target for nearly three years. However, the ongoing weakness in household sentiment along with the slowdown in business activity may keep a lid on consumer prices, and we may see central bank doves continue to press for more quantitative easing in an effort to ensure a stronger recovery.

Although the GBPUSD maintains the downward trend from earlier this year, the CPI report may spur a more meaningful rebound off of the 100-Day SMA (1.5866) should the data dampen speculation for additional monetary support. In turn, we may see the pound-dollar retrace the decline from back in September and the pair may ultimately setup for a bullish breakout as the BoE turns its attention to the stickiness in inflation. However, a weaker-than-expected print may spark a move back towards 38.2% Fibonacci retracement from the 2009 low to high (1.5680) as it fuels bets for more QE, and the bearish sentiment surrounding the sterling may get carried into the following year as U.K. policy makers maintain a cautious tone for the region.

Forecasts for a faster rate of inflation certainly instills a bullish forecast for the sterling, and the market reaction may pave the way for a long British Pound trade as it raises the outlook for future interest rates. Therefore, if the headline reading rises 2.4% or higher, we will need to see a green, five-minute candle following the print to generate a long entry on two-lots of GBPUSD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will establish our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the firs trade hits its mark in order to lock-in our gains.

On the other hand, U.K. businesses may cap consumer prices amid the ongoing slack in the real economy paired with the downturn in household confidence, and a slower-than-forecast print may spark a sharp selloff in the exchange rate as market participants maintain bets for more easing. As a result, if the CPI falls short of expectations, we will implement the same strategy for a short pound-dollar trade as the long position laid out above, just in the opposite direction.

Impact that the U.K. Consumer Price report has had on GBP during the last month

Consumer prices in the U.K. increased 2.2% in September to mark the slowest pace of growth since November 2009, while the headline reading for inflation held steady at an annualized rate of 2.1% during the same period. Indeed, the marked slowdown in the CPI print dragged on the British Pound, with the GBPUSD struggling to hold above the 1.6100 figure, but the sterling regained its footing during the North American trade to end the day at 1.6110.

http://forexforums.dailyfx.com/dailyfx-education-videos-forex-trading-strategies/89952-dailyfx-trading-news.html?cmp=SFS-70160000000ELfrAAG--- Written by David Song, Currency Analyst